Archive for March 2016

I have been doing some reading for my undergraduate thesis, which looks at the role of credit-supply shocks in the Spain during its housing boom and bust, and I came across some interesting thoughts from Bob Hall. Commenting on research by Alan Auerbach and Yuriy Gorodnichenko, Hall makes some useful points that contradict a lot of the received wisdom about the efficacy of fiscal policy:

I conclude that the chapter uncovers a proposition of great importance in macroeconomics—that the response to government purchases is substantially greater in weak economies than in strong ones. The finding is a true challenge to current thinking. The first thing to clear away is that the finding has little to do with the current thought that the multiplier is much higher when the interest rate is at its lower bound of zero…Standard macro models have labor and product supply functions that are close to linear over the range of activity in the OECD post-1960 sample. The simple idea that output and employment are constrained at full employment is not reflected in any modern model that I know of. [Bolding is by me, not Hall.]

On the economics blogosphere, the “current thought” is also that, because monetary policy is in certain respects (that is, if only by social convention) constrained when the policy rate hits zero, fiscal policy becomes discontinuously powerful at the zero lower bound. Once the policy rate is a quarter of a percentage point, time to turn off fiscal policy, one might infer. Scott Sumner is one of the clearest and most persuasive exponents of this view—see here, for instance.

I thank Evan for calling me “persuasive”, but there are days when I feel like I’m not making any headway. Just to reiterate, here are my basic views:

1. There is no such thing as “the” multiplier, in the sense of it being a deep parameter. It depends on how monetary policy responds. It’s an empirical question, and “the” multiplier may be time-varying.

2. If monetary policy is optimal, there will be no demand-side multiplier effects, even at the zero bound. (There may be supply-side effects.) When Evan refers to “this view”, he means that I don’t favor fiscal stimulus at positive rates, not that I do favor it at zero rates.

3. Previous studies suggesting a positive multiplier at the zero bound are marred by the inclusion of countries with and without monetary offset (with the eurozone being a particularly significant problem).

4. There was no fiscal multiplier effect when the Federal government suddenly reduced the deficit from $1060 billion in calendar 2012 to $560 billion in 2013, despite predictions to the contrary by over 350 Keynesian economists.

I took a look at the Alan Auerbach and Yuriy Gorodnichenko paper, as well as Robert Hall’s comments. I see two potential problems:

Their point estimate is that one added dollar of government purchases results in about $3.50 of added GDP when the economy is weak, with a 90% confidence interval running from 0.6 to 6.3.

I’m very weak at econometrics, but this doesn’t seem at all persuasive to me. I’ve always thought the standard 95% confidence interval is way too lenient, and helps explain all the bogus studies that cannot be reproduced. It’s an invitation to data mining. So why did they use the 90% confidence interval, instead of the already lenient 95%? Perhaps because at 95% the interval would include zero. In other words there would appear to be no statistically significant evidence of any multiplier effect.

2. Let’s say I’m wrong about the econometrics (quite possible.) My other concern is that I don’t see any evidence that they discriminated between countries with and without independent monetary policies (no list of countries was included). In other words, they should have excluded countries under fixed exchange rate regimes, as well as those in a single currency like the eurozone. Studies by people like Mark Sadowski, Kevin Erdmann, and also Benn Steil and Dinah Walker, suggest that when the data is limited to countries with an independent monetary policy, then the multiplier effect seems to nearly vanish, at least during the recent recession.

I don’t want to sound too dogmatic here. I have no doubt that WWII military spending caused measured RGDP to rise (although consumption and living standards fell.) So it’s possible that this paper did correctly find a positive multiplier. But I am not convinced that the Auerbach/Gorodnichenko paper has established a positive multiplier for countries with independent monetary policy regimes.

Religious people might name the arrival of a prophet. I might name the abolition of communes in China, or the abolition of slavery, or the defeat of the Nazis. Or perhaps positive innovations such as antibiotics, the Green Revolution, or the invention of cinema/TV.

It would be pretty hard to argue that China opening up to trade with the rest of the world doesn’t belong in the top 10, in any list of the best things that ever happened. Marcus Nunes directed me to this Noah Smith post:

Basically, opening up trade with poor countries such as China can be dangerous. But liberalizing trade with rich countries such as Japan, South Korea and those in Europe has very little potential downside.

The main danger from free trade is the so-called distributional effect. Opening up trade with China put U.S. workers directly in competition with Chinese workers who could do a similar job for much less money. That acted to the advantage of U.S. multinational companies that shifted factories to China, because U.S. companies were the ones with the capital to invest in new Chinese factories. But that hurt U.S. workers who were suddenly out of a job. Many manufacturing industries shifted to China and many laid-off U.S. workers were forced to take low-paying low-skill jobs, while others simply dropped out of the labor force. Trade with China has been great for rich Americans, but it’s been a disaster for much of the working class.

Is Smith suggesting that a policy that produced incredible gains to hundreds of millions of very poor non-white people is undesirable if it generates relatively small costs to a relatively small number of relatively affluent Americans? (Affluent by global standards.) I think so:

I find myself in an odd position right now. Having spent years criticizing the elite consensus in favor of free trade, I now am very reluctant to join the backlash.

One simple reason is that the backlash is being led, in part, by Republican presidential candidate Donald Trump and I’m disinclined to sign onto a movement of which he is a prominent leader.

But just as a stopped clock is right twice a day, there is a possibility that Trump is actually right on this issue.

Now to his credit, Smith goes on to indicate that he supports some recent trade proposals, but only because they would help relatively affluent Americans and relatively affluent Europeans, Asians and Australians. China is not involved. So he’s not as bad as Krugman. Nonetheless, any proposal that would massively improve the welfare of the people who most need economic development seems to be undesirable (in Smith’s view), as it would involve freer trade with very poor people.

Just to be clear, I do not accept the claim that China trade has done enormous damage to America’s working class. Contrary to widespread impression, the recent paper by Autor, Dorn and Hanson does not provide convincing data for a big net loss of jobs because of China trade. The job market did very well during the period they examined (1990-2007), indeed far better than in Germany (which had huge trade surpluses). In my view there has been little or no net loss in jobs in the US due to trade. Losses in some cities and gains in others. In addition, working class Americans (as a whole) have gained enormously from the lower prices resulting from Chinese imports.

But even if I were 100% wrong in my views of the positive effects (on the US) of China trade, I’d view opposition to China trade as morally indefensible. In the comment section, people will tell me that it’s the job of the US government to defend the interests of US citizens, and that we should not care about the welfare of the Chinese. I don’t accept that, and even if I did I’d still argue that China trade benefits the US. But these commenters are people with whom Smith would strongly disagree with on almost any other issue. He should think twice about whether he wants to be associated with people who don’t care at all about the welfare of hundreds of millions of poor Asians. Smith’s a liberal-minded person, and I’m sure he does care about the welfare of people in the third world. My guess is that this is just an oversight on his part.

Another possibility is that I misinterpreted his argument. (Surely the first time that has ever happened in the blogosphere!) I understand that Smith doesn’t explicitly advocate not trading with China, and that his post is forward-looking. But he’s relying on the claim of backward-looking studies (such as ADH) for his assertion that China trade hurt the US. I don’t see how you can rely on those studies, and still claim that your opposition to more China trade is merely forward-looking. Nonetheless if Smith wants to specifically suggest that previous trade with China was a good thing because it helped China develop, but he wants no more liberalization, I’ll amend this post. In that case I’d say his argument makes no sense at all, rather than being morally indefensible. Trump also says that our past trade with China has been a bad thing—at least that argument is consistent.

Remember the Sports Illustrated jinx? Athletes that appeared on the cover of Sports Illustrated often saw their performance drop off sharply. I wonder if the same applies to Paul Krugman? Here’s a Krugman post from 2013, trashing the Irish economic model:

The one sense in which Ireland has made some progress is that it has somewhat reassured bond investors that its population will continue to sullenly acquiesce in austerity; as a result, Irish 10-year rates, while still at a large premium, are now 60-80 basis points below those of Italy and Spain.

But the repeated invocation of Ireland as a role model has gotten to be a sick joke.

I’m not sure the Irish feel “sullen” about the 9.2% RGDP growth announced last week:

Notice that Ireland’s dramatic turnaround began almost immediately after Krugman’s August 2013 post. The post was entitled:

Ireland Is The Success Story Of The Future, And Always Will Be

Just to be clear, I think Brazil is going pretty well, and has had good leadership. But why exactly is Brazil an impressive “BRIC” while Argentina is always disparaged? Actually, we know why — but it doesn’t speak well for the state of economics reporting.

I first wrote this post on the day when Lula was indicted for corruption, and his successor is now threatened with impeachment for the same. In fairness, I would not expect Krugman to be aware of the political intricacies of Brazil. I’m more interested in his views of economic policy. So how has Brazil’s economy done since the May 2012 post, under that “good leadership”?

Yikes, that’s almost the mirror image of Ireland. While Ireland is already richer than Germany (In GDP/person, perhaps not GNP), and growing at a much faster rate, Brazil is now poorer than China, and declining as fast as China is growing.

Argentina also slowed sharply after Krugman’s post, indeed the slowdown was already underway in 2013, but he relied on the 2012 data, when growth was still strong. Fortunately they have a new government, which is beginning to institute some reforms.

PS. Another irony; didn’t the “country of the future” joke that Krugman applied to Ireland, originally apply to Brazil?

Matt Yglesias has a great post documenting the GOP’s shameful support for Donald Trump over the years, and how that’s legitimized his campaign. Even worse, they still refuse to disavow him—the GOP establishment won’t promise not to vote for him if he gets the nomination.

In my view, they made a calculated bet that he would moderate his views as he got closer to office, just as in the early 1930s the NYT said that a certain German nationalist politician (who I am not allowed to name) would likely moderate his views as he got closer to office. Instead, Trump is acting more and more like a fascist, as he gets more power:

Trump warns of ‘riots’ if he’s not the GOP nominee in a contested convention

“I think you’d have riots,” Trump said on CNN’s “New Day” on Wednesday.

Trump’s wins in Florida, Illinois and North Carolina on Tuesday put him at least halfway to the 1,237 delegates he needs to claim the nomination. But Ohio Gov. John Kasich’s win in his home state denied the real estate mogul 66 delegates in the winner-take-all primary, increasing the likelihood of a contested GOP convention this summer.

“I think we’ll win before getting to the convention,” Trump said. “But I can tell you, if we didn’t and if we’re 20 votes short or if we’re 100 short and we’re at 1,100 and somebody else is at 500 or 400, because we’re way ahead of everybody, I don’t think you can say that we don’t get it automatically.”

“I’m representing a tremendous, many, many millions of people, in many cases, first time voters,” he added. “If you disenfranchise those people, and you say, ‘I’m sorry, you’re 100 votes short’ … I think you’d have problems like you’ve never seen before. I think bad things would happen.”

Trump does not seem to understand how democracy works. The whole point of conventions is to deny the nomination to a candidate who has a plurality of the delegates, but not a majority. That’s why we have conventions. It’s just about the only reason to have conventions. Their purpose is to deny the nomination to a candidate who is supported by 40% (many not even Republican), but hated by a group of 60% who split their votes among other candidates. They keep voting until someone gets a majority—those are the rules. We have conventions so that we can stop crazy candidates with mere pluralities of delegates.

His supporters (in the comment section) will insist that he’s not “advocating” violence, just “predicting” it if he fails to get the nomination. Yes, that’s right, when Trump’s hypnotized followers hear him talk about violence if the nomination is stolen from him, that would not in any way encourage them to actually go out and enact what their Great Leader says is inevitable. The leader they’ve raised their hands and pledged allegiance to. Remember Chicago 1968? Get ready for a long hot summer.

If Trump comes into the convention 100 votes short, and gets the nomination anyway, the GOP party establishment (not the voters!!) will have picked him. Actually, 60% of GOP voters will have rejected Trump. The establishment will have forced Trump down our throats despite that rejection. And America will be a country with one legitimate major party, plus the tiny Libertarian Party, and our own version of France’s National Front.

Marine Le Pen, for example, has become a poster child for the modern European far right after leading the French National Front to unprecedented success over the past few years. Many see her as the most obvious European counterpart for Trump. And yet, despite their perceived kinship, Le Pen has personally criticized Trump’s proposal to ban almost all Muslims from entering the United States.

“Seriously, have you ever heard me say something like that?” Le Pen said during one television interview, according to the New York Times. “I defend all the French people in France, regardless of their origin, regardless of their religion.”

So to all you people who said, “How dare you compare Trump to the National Front.” I apologize—he’s worse.

Last December the Fed forecast 4 rate increases during 2016. That’s still possible, but increasingly unlikely. The markets forecast 2 rate increases. Today the Fed threw in the towel, and admitted that the market forecast was better:

The Fed’s expectations for GDP growth in the near-term dropped since December, while forecasts for core inflation remained mostly unchanged, and the median expectation for unemployment fell slightly to 4.5% by 2018.

Fed officials’ projections for the federal funds rate indicate two quarter-point rate hikes this year, a slower pace of rate increases than envisioned last December. The Fed previously expected to raise rates four times this year.

The downshift in rate increases may not be due to new concerns over the domestic or global economy, but may simply be an extension of the Fed’s January decision to keep accommodative policy measures in place.

BTW, that third paragraph makes no sense. If anything, it was caused by the Fed’s decision in December to raise rates.

Here’s what I wrote last December:

People laugh at how far behind Kocherlakota is on the dot graph, like the little boy that can’t keep up with his Boy Scout troop:

Only 1% interest rates in 2017? Yes, that’s probably too low, but it wouldn’t surprise me all that much if Kocherlakota had the last laugh. His 1% forecast is certainly far more plausible than the official who predicts 4% in 2017. Consider that Japan and probably even the eurozone are still going to be at zero in 2017. How plausible is it that the US has 4% rates when the rest of the developed world is at zero? Especially given that we are growing at just over 2% in a period of rapidly falling unemployment, and the unemployment rate will stop falling by 2017, and hence RGDP growth will slow sharply from the current pathetic levels. We might even have another recession, recall that America has never had an expansion that lasted 10 years.

It’s also important not to overstate the accuracy of market forecasts. Saying they are the best we have does not imply they are very good. There are certain things that are simply hard to predict—for instance markets are not very good at predicting recessions. (The yield curve is probably the best of a bad lot.) So the fact that the market was right and the Fed was wrong in this case (so far) does not prove anything. By analogy, examples where the market was wrong (and hence I was also wrong) also don’t prove anything.

For example, suppose the market forecasts 1.25% interest rates in 2018. The market might actually think 1.25% rates are unlikely, but that zero and 2.5% rates are equally likely. If we have a recession between now and then, rates will be at zero in 2018; if continued expansion, then rates might be 2.5%. Obviously I don’t know if that’s exactly right, it’s just something to keep in mind when looking at point estimates. I have no idea when the next recession will occur, but I do have a strong conditional forecast that when it does occur, rates will quickly fall to zero and stay there for many years.

This may explain the difference between the market and the new Fed forecast; only the market thinks a recession is possible:

Also note that the Fed’s new end of 2017 forecast is closer to Kocherlakota’s “crazy” 2017 forecast from back in December, than it is to the Fed’s own forecast back in December. And the market forecast is now almost identical to Kocherlakota’s December forecast for 2017.

You might say, “yeah, but he was wrong about 2016”. No, those are policy settings that the person deems appropriate. Thus they can only be viewed as predictions in the long run, as in the short run the Fed may be too tight to hit its inflation forecast.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.